Unemployment in the US is rising as are bond yields as we say goodbye to QE2

1st July 2011 by Shaun Richards

Whilst much of the world’s focus was on Greece yesterday another event was taking place which could easily turn out to be more significant with much less of a fanfare in the media. Not long after the Greek government won the second stage of its austerity package vote the US Federal Reserve undertook its last asset purchases of US government bonds under what has become called QE2. As it has purchased a total of US 600 billion dollars in eight months this means that it has bought an average of 75 billion dollars a month. Put another way since this programme started the US central bank has purchased around 70% of the debt its government has issued.

QE-lite continues

This is not a complete end to Federal Reserve purchases of US government bonds however as it has another programme which purchases them with funds received from maturing mortgage backed securities that it has in its portfolio. However this is a much smaller programme which purchases between 15 and 25 billion dollars per month depending on how many MBSs actually mature. As you can see the scale of purchases going forwards will be much reduced.

What did the US government bond market do in response to this?

I wrote yesterday that US government bond yields had risen strongly this week with the ten-year maturity whose yield closed below 2.9% on Friday rising to 3.11% at Wednesday’s close. This rallying of yields continued as the ten-year yield closed at 3.16% meaning that this week alone we have seen more than a quarter point rise in the yield on these bonds.

So there has been no sign of a post Greek agreement rally here as the rise in yields means a fall in prices. I am also reminded of the press conference given by Ben Bernanke the chairman of the US Federal Reserve announcing the end of QE2 when he stated that pre-announcing its end would mean that by the time it happens markets will just shrug it off. We are very rarely able to look at one event in isolation but it does appear that the end of QE2 has led to a rise in US government bond yields and perhaps more worryingly for the programme they are now higher than when it started. So as reducing them was an objective of the plan it did not succeed in achieving this as instead ten-year yields have risen by more than 0.6%.

The US unemployment situation

In my opinion the primary objective for the US Federal Reserve with its QE2 programme was to improve the US unemployment and employment situation. I have given quotes from their statements and speeches many times to evidence this. As QE2 progressed it looked like some success was being achieved in this area as unemployment fell and the employment situation improved. However recently this improving trend has turned downwards and if we look at yesterday’s figures for US initial jobless claims we can see the latest numbers.

In the week ending June 25, the advance figure for seasonally adjusted initial claims was 428,000, a decrease of 1,000 from the previous week’s unrevised figure of 429,000. The 4-week moving average was 426,750, an increase of 500 from the previous week’s unrevised average of 426,250.

If we combine this with the previous numbers in this series we see that the headline weekly figure has been over 400,000 for twelve weeks in a row now. Also the four-week average has nudged higher and is well over 400,000. So the improving trend of the early part of 2011 has ended and we are back to similar figures to those we saw in January. I expect these numbers to influence the employment report for June because we have had only one poor monthly report so far but twelve poor weekly initial claims figures.

Accordingly QE2 has ended on a sour note if we look at the trend for unemployment. Yes the level of unemployment has fallen since it began so there has been some progress but the current level of initial claims implies that it might now continue the rise we saw in May which reversed some of the improvement. The real issue with this is that we were supposed to be solidly in an economic recovery by now and instead we have more questions and more problems.

The Rise of the ninety-niners

For those unaware the significance of the phrase ninety-niners is that after 99 weeks official US unemployment compensation runs out. If we look at the numbers for Extended Unemployment Compensation and Extended Benefits then it looks like around 27,300 people found themselves in this position last week. They find themselves in a grim position where not only has the official help run out but the duration of their unemployment makes it ever harder to get another job.

Comment on the end of QE2

We will have to see how things settle down in the coming weeks and months but as we stand QE2 has had very patchy results to say the least. I have reviewed the comments when it started and many were claiming then that the objective was to reduce bond yields and instead they have risen. If we look an unemployment an initially improving trend has shown signs of reversing. Critics of the policy,which include me, would further argue that  the liquidity created by this programme has contributed to the commodity price boom that we saw in the early part of 2011 which had the follow-on impact of raising food prices which then was a major cause of the so-called Arab Spring.

The one clear positive from the programme has been the improvement in US equity prices. This should have a positive influence on the US economy via wealth effects but such effects are quite weak.Perhaps also we can add that the US housing market has started to show it is not declining as fast as it was and may be beginning to stabilise. But this is a long way short from the hopes that the Federal Reserve must have had back in early November 2010 when QE2 was announced. Also we have to factor in the fact that at end of 2010 we saw the US government extend what is still a very expansionary fiscal policy.

The US debt ceiling

This is a relatively simple concept where the US Congress has set by law that the United States cannot borrow more than US 14,300 billion dollars and this is what is called the debt ceiling. However this was actually hit in the middle of May and as it would have been headline news around the world if the US government had closed down I think we can be sure it has not! What is actually happening is that various tricks and ruses are being used so that whilst officially the debt ceiling remains in reality it has been exceeded, an example of this is that various instruments on the Federal Reserves balance sheet have been used to help in this. Something needs to be done by early August as the tricks and ruses will run out then.

I expect a solution to be found as the shock effect of defaulting will focus political minds out of their current logjam. However it is the same politicians who put the US in this position when at the end of last year they approved the new extra fiscal stimulus or when in April they approved a budget deficit of US $1700 billion for this fiscal year. So yet again I find myself shaking my head at their willingness to ignore reality….

The Price of Corn

Yesterday we got something of an ironic and symbolic present for the end of QE2. The price of a bushel of corn fell by 70.5 cents or just over 10%. Please do not misunderstand me whilst I do feel that QE2 contributed to the rise in commodity prices I would be surprised to find that its end directly caused this drop in corn prices.

Actually the circumstances of the drop reminded me more of the plot from the film Trading Places where the official estimate of the orange juice crop if I remember rightly was less of a surprise to some than it was to others. On this occasion the US Department of Agriculture released a much more optimistic report on the state of the corn crop than was expected. I have to confess I do wonder how supposedly professional traders were this badly wrong-footed.

It also makes me think of the influence of  official institutions on markets. Only a week or so ago we saw the International Energy Agency release reserves to reduce the oil price and this week we see the USDA produce a report leading to fall in corn prices. Or to be more specific we may be seeing the response of official institutions to the effects of past official action as the rises in these prices was strongly influenced by the amount of liquidity that central banks have unleashed upon the world. The more I think like that the more I am convinced that this is a long way from the way that capitalism is supposed to be and that rather than being the solution to our problems they are in fact part of the cause.

A Troubling development

From the Bank of England

In parallel with the Bank of Canada, the European Central Bank, and the Swiss National Bank, the Bank of England is today announcing an extension of its temporary swap line with the Federal Reserve to Wednesday 1 August 2012.  The Bank of Japan will consider the extension at its next Monetary Policy meeting.

I will leave you with a simple question about this, why is this still necessary when in the early part of 2010 it was considered to be no longer necessary?

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8 thoughts on “Unemployment in the US is rising as are bond yields as we say goodbye to QE2”

  1. James says:

    Hi Shaun,
    As fascinating as ever. I see that the Fed has bought 70% of the issue of US debt this year. I also see that the deficit this year is supposed to be $1700 billion.
    I think that the numbers have become so big and so frightening that we are like rabbits caught in the headlights here. We have gone past the point where there is any feasible way out other than a major decline in living standards.
    The Ponzi scheme of QE seems to me to be the last resort of scoundrels.

  2. Anonymous says:

    Hi Shaun
    Reuters say that European banks need dollars to fund their dollar-denominated assets such as mortgage bonds and dollars could be scarce in a crisis – strains in short term funding markets continuing?

    I have just left a comment on Simon Ward’s blog. He makes worrying comments about regulator-bouyed gilt buying which could be weakening and he refers to a weak M4x figure annualised at 1%. In 2009 the BoE told us to watch this indicator as the economically relevant one to gauge success of QE…

    1. Anonymous says:

      Hi Shire

      Yes that is so there does appear to be continuing demand for US dollar denomintaed assets that is not being satisfied by normal market actions. I have just replied to Noel above on this topic but adding to it here in recent times have been three things.

      1. There have been more strains in Euribor than US dollar Libor. I know that this reduced a little on FrIday but has not yet gone away.

      2. Evidence has emerged that a lot of the money from QE2 went to foreign institutionsbanks rather than US ones. As you know I am wary of how accurate specific figures like this are but a trend towards it does seem clear. But the main route here has now ended with only QE-lite ongoing. Will this make it worse?

      3. There have been strains also in Chinese money markets as Mr.K pointed out about ten days ago with Shibor pushing higher.

      So for now the best explanation I can manage is a sense of unease from some of the developments with soe troubling issues but no clear theme.

      As to the gilt buying I followed a timescale roadmap given a while back by Charles Goodhart and yes I too think that we will soon be much shorter of gilt buyers than we were as we have been through a period with QE and rule changes that have again manipulated the market creating the danger yet again of a false market.

  3. What is the temporary swap line and what relevance might this have to our situation? Ipis

    1. Anonymous says:

      Hi Noel

      It is analagous to calling for International Rescue! When the crash of the credit crunch really hit home than the US Federal Reserve supplied US dollars to many banks around the world to fix what was a dollar shortage.Just to be clear much of this went to foreign banks and not just US ones. This begs a lot of questions as to the role for example of the ECB or the Bank of England. They are supposed to be the lender of last resort……

      So why in the supposed recovery do we need what in equivalent analogy might be a firehose with plenty of water in it for? It begs the question that central banks feel we might need it again which begs the question is there something they know that we do not?

      You might argue that it is bureaucratic inertia where it exists and is being continued but that hits the problem that it was stopped for 3 months in 2010 ( Feb to May if I remember correctly).

  4. graeme_b says:

    “Unemployment in the US is rising as are bond yields as we say goodbye to QE2”
    but Gavyn Davies, OBE, at the FT said it’s the stock that’s important, not the flow 😮  

    Could Gavyn Davies, OBE, be wrong???

    1. Anonymous says:

      Hi Graeme

      When Quantitative Easing was first suggested in the UK and US its advocates concentrated on flow effects and discussions of the stock effect were conspicuous by their absence. When QE stopped in the UK we then saw the Bank of England discussing stock effects and since then others have joined in. So a discussion of stock effects in the US is consistent as they have now ended their main programme with only the smaller QE-lite continuing.

      Monetary policy has lags in it so my question to them on a conceptual level would be how will they tell between lagged flow effects and stock effects?

      Over time we have seen a myriad of explanations of how QE is supposed to work. If we look back it is clear that many were indeed wrong. So yes Gavyn Davies can be wrong.

      As for the full impact only time will tell as QE2 has only just ended. However if I put my own sceptical views to one side and try to put myself in the shoes of a supporter I can only think that they must be disappointed by the effects so far both in the UK and US and indeed Japan.

  5. QE2 mostly involved securities purchases from bank which only increased excess reserves in the banking system. Even purchases from private owners didn’t seem to create and meaningful difference. The money was probably invested either in commodities (since yields on more conventional investment vehicles are low) or in debt repayment.

    Targeting amount instead of price is rather silly. Just as the Fed can target a federal funds rate (and stand ready to provide or withdraw enough reserves from the banking system in order to achieve it) it should just target a specific yield curve. No one in the market can go against the Fed if it decided to invest unlimited funds in achieving it’s objective. So QE2 was ill planed from the start.

    The only government authority which can implement a policy with meaningful results on the unemployment rate is the treasury through federal fiscal policy. The federal deficit is still smaller than the private sector’s deficit (in income, net worth). As long as no one provides the additional demand in the economy (through exports, private sector borrowing or fiscal policy), unemployment will remain high.

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